Tom Stewart, Executive Director of the National Center for the Middle Market, and Doug Farren, Managing Director of the Center, sit down with Dan North of Euler Hermes, a leading economist. They discuss current economic trends and outlooks and how those might affect the market.


 We're nearly a decade into the third longest expansion in US economic history. Confidence is high among businesses and among consumers. The middle market is leading the way. But will it last? We'll talk to a leading economist to find out. 

Welcome to The Market That Moves America, a podcast from the National Center for the Middle Market which will educate you about the challenges facing mid-sized companies, and help you take advantage of new opportunities. 

I'm Tom Stewart, the executive director of the National Center for the Middle Market at the Fisher College of Business at the Ohio State University. We're the nation's leading research center studying mid-sized companies, which account for a third of private sector employment and GDP, and the lion's share of economic growth. It is the market that moves America. The National Center for the Middle Market is a partnership between Ohio State, SunTrust Banks, Grant Thornton LLP, and Cisco Systems. 

With me today is Dan North, who is the chief economist of Euler Hermes, an insurance financing company. He will tell you about it in a minute. And also with me is Doug Farren, the managing director of the National Center for the Middle Market. Dan, Doug, glad to have you. 

Thanks for having us. 

Thanks, Tom. So Dan, thanks for joining us today. We heard you speak a little earlier at an event here in Columbus, giving some of your latest outlook on the economy. Maybe you could first just tell us a little bit about Euler Hermes, kind of what you do. And then maybe start by telling us about your forecast and outlook on the US economy. 

Sure. Thanks very much again for having me. Euler Hermes is the world's largest provider of trade credit insurance. And basically the way it works is, if you're a business selling to other businesses on open account, you sell them goods and services and hope to get paid back. But you run the risk that the guy you sold to will go bankrupt and not be able to pay you back, or just pay too slowly. We cover our clients against that possibility. We cover them for nonpayment. 

We've been around for over 100 years. We've got offices in 52 countries around the world. We're double A rated by S&P. We're majority owned by the Allianz Group. And globally we insure over a trillion dollars in sales every year. As I mentioned, we are the leading provider, and we are the leader in most of our markets globally, as well. So that's basically what we do. 

You know, one of the other benefits to trade credit insurance, not only is it for non payment, but a lot of our clients use us for sales expansion. Because if they want to sell to someone they don't know about, or sell into a foreign market they don't know about, we probably do know about them. Because again, we have offices all over the world. We have a database of 45 million companies. And we probably can help you grow to those businesses. 

So, Dan, I'm thinking that your business, that Euler Hermes's business is an amazing crow's nest. You see the deals between companies where goods and services are being sold and shipped. Is there a unique perspective that you get from that? 

Oh, for sure. We have very close contact with our clients. We have a large coverage, but we have a coverage of small limits that we never really look at, because they're all covered by computer operations. They're all automated. But they're very small exposures. The big exposures-- we have the big exposures that we have risk to-- we have a team of underwriters who are very good, that watch these risks all the time. And we, again, have close contact with our clients. Because they tell us every month about their payment experience-- who's paying them slowly, how far behind they are, for how much. So we get a really down-on-the-ground look of how things are paying out on the ground. 

And how do things look? 

From that perspective, pretty good. Pretty good. It was obviously very, very difficult during the recession. We actually built an index, what we call a payment behavior index. And right now, it's pretty strong, as you might expect in this phase of the economy. It's a pretty solid outlook. You were asking for our general outlook before. And solid is the way I would put it. Most of the fundamentals are really in good condition. We're looking at 2.6% GDP growth this year, if not some more than that actually. 

We've got the consumer doing well. We think wages are going to pick up this year. Manufacturing's doing well. Housing is contributing. We have a pro-growth agenda. It's all pretty solid, and that's solid turns into 2.6%, maybe 2.8% growth. That's not as exciting as it used to be. But there are some demographic factors that are holding our growth rates down. And they are sort of a long-term thing that we can't help to overcome right away. So other than that, it's a pretty nice outlook. 

So you mentioned a strong outlook, but moderate growth. With recent changes that we've been seeing-- tax laws, the rising rates, tighter labor markets-- what should executives be looking for? What are some of the dials that you would recommend as a CEO or a CFO maybe at a mid-sized company? What should they be watching most closely? 

Right. Well, you mentioned the labor market. And that is actually, we're finding, talking to clients and trade groups, that is one of the biggest constraints they're facing. Because again, with a solid economy, this is an opportunity for them for the first time in years to be able to really grow. And they'd like to be able to grow. But I hear comments from people all the time like, I can't find anybody. We'd love to be able to grow faster. We could grow faster if we could find anybody. 

So the labor issue I think is probably the primary thing out there that CEOs and CFOs have to think about. And you know, they're actually getting to a point now where they're involving local community colleges, because they can't find the people with the skills. Actually establishing programs to teach these kids skills that they need, their businesses need. 

It's also interesting to note that the tightness in the labor market is unfortunately in part due to, it's very hard to find potential employees that can't pass a drug test anymore. Because we have this opioid epidemic, and we have increasing social acceptance of marijuana use, that really kind of even cuts the labor pool that's available even now. 

We've got data that show that just about four out of 10 mid-sized companies say that a lack of talent is constraining their growth. And another hopeful piece of data, and I'd love to hear your comments on this, your thoughts about this, is we've also seen a big jump in the number of employers who say that they're willing to invest more in training and development than they were. So are you seeing-- does that show up in the economic data, or in the stuff that you're looking at? 

It shows up when we're talking to clients and trade groups. I mean, this is exactly what they're saying, is we have to get more involved, because there's just nobody to hire. So we have to create them. And this is one of the reasons that productivity has been so low, and our recovery, is that there just aren't enough people with the right skills to get hired. And so when they eventually do get hired, their productivity is pretty weak. 

And you were also asking about other things that CEOs and CFOs should look for. There are a couple of things. One, when small and medium-sized businesses, perhaps their people that they're selling to want to expand too fast, which is a risk now. Because a lot of small businesses are saying, again, this is the time we can expand. We really want to grow. 

When they start to grow too rapidly, they increase their risk of bankruptcy, actually. They outgrow themselves. Because they send more and more stuff out the door every month. They're selling more and more stuff, which costs money to produce. But then they don't collect on the receivable fast enough, and their cash flow goes negative and they go bankrupt. And when we talk to accountants and bankers, this is a very common phenomenon. So you have to look carefully at that. If you're selling to businesses that are trying to expand really rapidly, there's a risk there. 

I also think that there's a little bit of inflation risk coming up. Because the administration now has plans to really juice the economy with fiscal policy. The tax plan, I think, was a really great idea. I think it's going to boost the economy, put more money in people's pockets, and particularly on the corporate side with that corporate tax holiday. Money is going to be coming back in. It will be invested. Not all of it, of course, but I think companies are actually anxious to invest, because they haven't been able to in the last 10 years. 

Now, in addition to that, there's also been the continuing resolution, which put in $300 billion of spending for infrastructure and military, for disaster spending. And then there's an infrastructure plan. And then there's plans in the budget. And all of this goes through, it might be too much. It might juice the economy so much that we'll start to see inflationary pressures rise faster than they should be. That's something that we kind of have to look out for. You don't want to suddenly see GDP growing at 6%. That's when you're going to get an overheating economy. And that's something to keep an eye on. 

It's been a long time since we have had inflation, significant inflation, almost to the point where I can imagine that there's a generation of CFOs that has never coped with it. So I mean, as you think about the risk-- and by the way, also, our middle market data show an increase in the number of companies that say they expect to raise prices this year. So they're saying their costs are-- an increase in concern about costs, and an increasing willingness to raise prices. So they're showing the same thing. But how does that change your behavior as a CEO or a CFO if you're working in an inflationary environment? That's got to lead to a different set of decisions, doesn't it? 

Right, right. So if you're starting to see higher input costs, you can do two things. You can try and pass them along to consumers, that's pricing power. Or you can compress your margin. That is, you make less profit. You let those costs go up, those input costs, but you don't raise your prices. 

Or you can increase productivity. 

Yeah. Tell me how to do that. 

You're the accountant. 

Right. Right. So that's been really hard to do. And again, part of that is because of the lack of skilled labor. Part of it is because of this explosion of regulation, which produces employees that are doing nothing but making sure transactions comply with the law. And their productivity is basically zero. Productivity takes a little while to juice up. It can get pushed up, I think, with this deregulatory push. I think it can get juiced up with the new investment that we expect. Because investment's been pretty weak over the past decade. 

Now with, again, with this change in tax laws, and being able to expense things right away, I think we'll see a surge of investment that will lead to productivity. It doesn't happen right away, but we could certainly see a bump this year. But it's pretty hard if you're running a business to say, I'm going to buy that machine, or hire these people, and our productivity is going to jump 5%. That's tough. 

So what a lot of employers are actually doing-- and again, this gets back to the skills mismatch, hiring people that can't do their jobs well. Well, there are two things to think about. They're starting to get more involved in community colleges, to teach these kids the skills that they need. And they're also, again, with this skills mismatch, that's one of the things that's actually held wage growth down a little bit. Because what's happening is, you can't find the people that are skilled and hire them at a skilled wage. You have to hire unskilled people and train them. And that's why wage growth has been slow up to now. We do think wage growth is going to pick up. 

And getting back to that inflation situation, as well, that you're talking about, we do think we see inflationary pressures bubbling up. It's not going to be anything like it was. A lot of people don't realize or remember what it was in the '80s, when you had inflation rates of 14% and 15%. We really don't expect to see that. But we do expect to see inflation go up from the less than 2% that we've seen for the past number of years. 

Also another thought about inflation. When the Fed started to print money, a lot of us were convinced that all that extra money would cause consumer inflation. And it didn't. But it did cause asset inflation globally. Assets were bid up, because-- 

Assets like plant and equipment housing. 


Bonds and stocks. 

Exactly. Housing, valuations in stocks are very high. And yields are very low globally. You still have negative interest rates in part of the world. That means the price of those securities have been bid way up. That's where the inflationary pressures went for some time. Now I think you're going to start to see it in consumer prices, as well. 

So despite some of these headwinds and challenges, we continue to track confidence of mid-sized companies at the global, national, and local levels. And we see them at all-time highs, Similar to some of the consumer confidence data. What do you think is fueling that optimism? 

Well, there are a couple of things. One, we've got a pro-growth agenda in place, or at least proposals for a pro-growth agenda. And you saw that when that happened when Donald Trump was elected with a pro-growth agenda, business loved that idea. Because they hadn't seen pro-growth measures in a decade. 

And they'd seen basically almost a demonization of business, and a great deal of uncertainty from Washington about business. So business kind of was very delicate in terms of making investments, for instance. They really didn't want to do that. Now you have this pro-growth agenda. All politics aside, that's inspired a lot of confidence. 

And you saw that in a rising stock market, and you see that in a couple of other surveys. The National Federation of Independent Business survey, it focuses on small businesses. After the election, that Small Business Optimism Index took a record leap, and is now at a record-high level. So I think that that's a large part of it. 

What was a little surprising, as well, is that global growth has come into harmonization for the first time probably, again, in virtually a decade. We weren't really necessarily anticipating that the US and Europe and Japan and China and other emerging markets would all start to grow in harmony at the same time. That is definitely confidence inspiring. But it's that pro-growth agenda that's in place, which we can also talk about diverting off later what the risks are involved in that. But in terms of confidence, that's what's really doing it. 

So part of what you're saying is that when we say that companies are extraordinarily confident, you're saying with good reason. The fundamentals are strong, even though we are very long into this expansion, are you seeing any sort of other distortions? I mean, usually when you get deep into an expansion, there are sort of weird things that started emerging that often aren't clear until afterwards. But do you see any sort of distortions in this picture? 

Yeah. I mean the clearest one is the labor market. During the recession we had a great proportion of potential labor go off on the sidelines, because they could. There were enough benefits, and still to a certain extent are enough benefits that you could live at home, you could live in the basement, and you didn't really have to-- you could make enough benefits that you didn't necessarily have to go to work. So there was a distortion there. And this has come back again to haunt us, because people haven't been able to work during the recession. Kids would get out of school and there were no jobs available for them. So they weren't able to build up that productivity and those job skills. 

That personal human capital. Yeah. 

Yeah, absolutely. So there is definitely a distortion there. Unfortunately, one of the downsides of this aggressive fiscal policy, this pro-growth policy, is, again, as I mentioned, we might get too juiced up, and could spark inflation. There's a risk there, as well, when small businesses become overoptimistic. There is that desire to expand too rapidly and increase the bankruptcies. 

Overall, though-- I mean these are distortions. You get distortions in any part of the economic cycle. But those are the kinds of things I'm looking at. One thing I haven't really talked about or mentioned much, because I think it's off in the distance, is that the classic central bank mistake is too much easy money for too long. And that's what the Federal Reserve did-- 0% interest rates, 0% rates, and virtual money printing with this quantitative easing. 

And it wasn't just the Fed. It was the European Central Bank, it was the Japanese Central Bank, Bank of England, Bank of Canada-- all very low interest rates. That has to get unwound. And when you build up assets with so much liquidity, unwinding it is tricky. And in the long run, I mean, we're talking about a few years out, that could be a real-- well, let's see if I can come up with the right word. It could be a not-great situation, and could certainly lead us into an economic downturn. 

So the question is, as the Fed-- there's a difference between the Fed's tightening and the Fed's putting a noose around the economy. And there's a fine line, right? 

Right. That's always the balancing act that the Federal Reserve or any central bank has to worry about. Because they have to make that balancing act between an economy that's running too hot or too cool. If it's too cool, you don't have enough people working. If it's too hot, you've got inflation running. 

The problem is, for our Federal Reserve and other central banks, is it's not inflation today that they have to worry about. It's inflation a year from now that they have to worry about. Because monetary policy decisions-- hiking interest rates 25 basis points today-- that doesn't get felt in the economy, it doesn't work its way through the economy for virtually a year. So it really is a tough balancing act for a central bank. 

And they've been pretty clear that they're going to do three hikes this year. I think they might do four by the end of the year, because I think, again, these fundamentals are really strong. And inflationary pressures, wage pressures, I think, are going to be there. But still, once you do that, the Fed funds rate is still historically really low. So I don't think that they're going to be choking off the expansion. Certainly not this year, and probably not next year, either. 

So looking forward to the rest of this year, 2018, and even into 2019, what would be maybe three things that companies should keep their eye on? 

Well, let's see. I think I talked about the inflationary pressures overly juicing the economy. 2018 midterms are something to be concerned about, but political handicapping is really, really difficult. If you looked at what's happened, tried to follow what's happening in Washington over the past number of years-- for instance, debt ceiling debates, or shutting down the government. They often come down, always, all of them come down to the last minute. And sometimes it's really clear that that's going to get fixed. And sometimes it's not. So that great deal of uncertainty is tough. And you see that in trying to call political handicapping. 

So the midterms could be difficult, because if the Republicans lose one house of Congress, the Trump presidency is pretty well over. Because they're just not going to be able to get anything done. So that's a pretty big risk sitting out there. 

And then there's always the exogenous events, which is a big word which means just from outside. Those are the ones you can't forecast, that make every economic forecaster look stupid. Because they ruin forecasts. For instance, let's say we have a hot conflict with North Korea. Well, that's going to throw everything off here. You know the forecast is going to be worthless after that. 

Another thing that I worry about is trade. Because this administration is pretty anti-trade. And they get it one-third right, which is that trade destroys jobs. It does. And that's really visible, because when a company announces they've got to close and move to Mexico, that's headlines. What you don't see is when trade opens up new markets, and small businesses get created, and middle market businesses start hiring people. That's the expansion that's not visible. But on net, that's what wins out. 

Our data consistently show that middle market companies that participate in international trade, buying or selling, add employees, I think it's about 25% faster than those that do not. 

Yeah. Yeah. And so we're now at this point where we've got this risk standing out there with NAFTA, which I didn't really think was much of a risk. But now it is a risk. NAFTA trade with Canada, Mexico, supports 10% of our job force, supports 14 million jobs. And it's an enormous-- it's the biggest portion of our export markets are Canada and Mexico. So trying to back out of NAFTA would really be almost disastrous over the next couple of years. Certainly would be much worse for Canada. But the point is we've got to embrace trade. And I think that's not what we're seeing, and that's a risk sitting out there. 

So Dan, just to wrap this up as we come to the end of our conversation. First of all, I'm hearing, overall things look good. We're deep into an expansion with no obvious signs that it's long in the tooth. Or in fact, it seems to be somewhat accelerated. I see a few things that people should be watching for. You mentioned getting over-- I hear that companies should be making sure to look at the quality of their sales as well as the quantity of their sales. To guard against this getting out over their skis, and they should make sure that they're looking at that. 

That they should think about the proactive steps that they can take on their own to get more than their fair share of what labor market is out there, because there is a labor shortage. And what can I do to get what I need and build my own labor force? That they should be thinking about what they need to do to hedge against what inflation might appear. Whether they can pass on costs in the form of higher prices, but also how to cope with a somewhat more inflationary environment, and rekindle those skills. 

That's the sort of picture you're painting. That it's full speed ahead, but there could be some icebergs out there. And those are three of them that you want to make sure that you're looking out for. Is that pretty good summary? 

Did you need me to come in today? 

No, no. That's what I heard you say. Is that it? 

That is largely correct. And again, I want to emphasize that, sure, there are long-term risks sitting out there. But right now it's one of these situations where we really do have an economy that is quite solid. To overuse a generality, firing on all cylinders. 

Consumer is consuming at a reasonable rate, but we think that's going to go up this year. There are a number of reasons that we think the wages are going to rise, and therefore consumption will rise. Manufacturing is doing very, very well. Housing's contributing. The fiscal policies I think are doing quite well and boosting the economy. Really hard to find something that's amiss. And that's really nice. We haven't seen that in a long time. 

There's got to be a hole in the donut somewhere, but we don't know where it is. 

It's further out. 

It's further out. Eventually it will be there. 

But I want to thank you very much, and thank you Dan North for joining us. Dan, to recap, is the chief economist of Euler Hermes. You can find more about Euler Hermes at their website, which is Euler Hermes-- that's EulerHermes.us. And you can learn more about them there. And you can learn more about us at our website, which is MiddleMarketCenter.org. 

Again, thank you very much for listening to The Market That Moves America. Never miss a new episode-- subscribe to the podcast on iTunes, Stitcher, Google Play, or wherever fine podcasts can be found. Or, as I said, you can subscribe and learn more about us at our website, MiddleMarketCenter.org.